Bank of Japan Slashes Rates

Wednesday, 6 October 2010

Japan is considered by many to be a Westernized country - with much the same financial and technical influence as typical Westernized countries such as USA, UK, and Australia. However, when it comes to sovereign finances, and the macroeconomics of the country, there are a few significant differences between Japan and the aforementioned developed nations.

One of the most obvious and significant differences is that of the OCR (official cash rate). The official cash rate is the rate at which a government / central bank is happy to lend out money to retail banks at. Of course, the rate is extremely important because it has wider effects on the bigger economy - i.e. in the pricing of retail savings and loan rates for example.

Japan is in the unique situation of having the lowest official cash rate of all the developed nations in the world. Currently, the OCR is quoted as being at 0.50%, but anyone who knew even the slightest amount about Japan would understand that the "real" rate is far lower than that (closer to 0.1%).

Why are we discussing this? Well, on Tuesday, an extremely influential announcement was made by the Japanese central bank stating that the OCR was to be lowered further. The new rate is now "officially" set at 0.25% - but once again this is not really the "actual" rate that the market uses.

Instead, the rate at which banks will probably be able to negotiate overnight interest through the central bank will be just a slither over 0.1% - potentially as low as 0.05%.

What is the impact on the Japanese economy of this unanimous decision by the central bank? Ultimately, it is that consumers will be able to acquire financing at lower rates - and therefore expect to pay less interest on their debts in the future.

Another positive of course is that business and corporate consumers will be able to access business funding at lower rates - encouraging capital expenditure for projects such as research and development.

Finally, the lower rate will potentially stimulate the economy through consumers and business spending - however the additional effects of this are as yet unknown. After all, it's not as if rates are dropping significantly. Borrowing in the country was still extremely cheap just a few days ago - and now is even cheaper. We will therefore have to wait a while to see any benefits to the demand / supply equation from this recent move.